Social Question

Was the collapse of Lehman Brothers a colossal failure of common sense?

I just finished Lawrence McDonald’s book which offers an insider’s look into the final years of Lehman Brothers, which was the fourth largest investment bank in the US before declaring bankruptcy on September 15, 2008.

Which actions led to its demise? Or was it just the ignorant CEO Richard Fuld who seemed to have run the company like a kingdom? Were declining ethics equally responsible for Lehman’s collapse? Is Treasury Secretary Henry Paulson to blame?

Lehman’s last chance came when George Walker IV, cousin of President Bush, calls the White House on September 14, 2008. The President, however, refuses to take the call, and bankruptcy ensues. See also

On the morning of June 7, 2005, some 45 traders and researchers gathered in a third-floor conference room at Lehman Brothers Holdings Inc. for a 7 o’clock briefing from Michael Gelband. The global head of fixed income introduced himself and proceeded to drop a bombshell, writes Lawrence G. McDonald in “A Colossal Failure of Common Sense,” a scathing and sadly overheated inside account of how Lehman became a house divided that could not long stand.

“Mike said flatly that in his opinion the U.S. real-estate market was pumped up like an athlete on steroids,” says McDonald, a former Lehman vice president of distressed debt and convertible securities trading who says he was in the room that day.

This was not what Chief Executive Officer Richard S. Fuld Jr. wanted to hear. At the time, Lehman was still making a fortune by buying up mortgages, packaging them into collateralized debt obligations and selling them off. Yet Gelband was daring to broach an “unspoken question,” McDonald says: What if the property market crashes and we get stuck holding billions of dollars in securitizations we can’t sell?

Fuld refused to listen, either then or later, as danger drew ever nearer, according to this understandably one-sided account. “King Richard,” as McDonald calls him, was too busy up in his 31st-floor office spending billions of dollars to buy commercial real-estate and stakes in hedge funds. Time and again, Fuld refused to heed compelling evidence gathered by his own staff that the U.S. real-estate market was living on borrowed time, McDonald says. By the end of 2007, Lehman’s liabilities had swelled to 44 times its worth. And still, McDonald says, Fuld wouldn’t listen. McDonald says that Gelband, a member of the executive committee, pounded the table at one meeting that took place while Lehman was considering buying yet another hedge fund.

“This is going to be the granddaddy of all credit crunches,” Gelband shouted. “And you’re trying to buy into a giant global asset bubble.” Fuld, true to form, later responded to Gelband’s concerns by bullying him. “I don’t want you to tell me why we can’t,” Fuld told Gelband by this account. “I want you to be creative, and tell me how we can. You’re much too cautious.”

Most people disagree with me and call me a flaming liberal, but to answer your question:

The whole problem is the existence of corporations. Corporations are the invention of government. Allowing companies to own themselves, and to raise insane amounts of money, gives them way too much influence over lawmakers and power over public policy, to the detriment of the public good. If all companies had to be owned by actual people (proprietors and partners) and had to raise money the old fashioned way (by taking out business loans for which the owners are personally liable, and selling products that people want to buy) no one company (or small group of companies) could have grown “too big to fail” and caused a world-wide recession by going bankrupt, and none of this would have happened.

@BoBo1946 – Actually, it’s obvious to people who actually read my answer that I do believe in the free enterprise system. It’s obvious that you are the one who doesn’t. The presence of corporations (a legalistic invention of government) thwarts the workings of free enterprise. These corporations can basically “print money” just by issuing stock and become insanely wealthy. They can then basically own every politician, and directly control public policy from the sidelines. They then have the power to bend the law to their benefit, giving themselves monopolies and crush small business. Plus meddle in the law in other ways to benefit their profits, i.e. copyright, etc.

To answer the original question, Lehman thought they would be rescued, just as almost every other major institution has in the past. Not a terribly inaccurate thing to believe.

I wouldn’t call Fuld’s actions stupid. I think Lehman would have been bailed out if his creditors were American and European banks instead of mainly Asian banks without political clout.

I don’t think he could anticipate where the line would be drawn where the gov’t would stop guaranteeing 100% of debt.

Now, was he running the place like a kingdom a few years before. Partly. I’m more inclined the believe that the man just did not understand risk exposure and offloaded that responsibility to the ratings industry.

Fuld was in a tough position for a long time. Basel II made everyone pretty equal and hard for Lehman to compete for business. Had to swing big (leverage) or fall behind to others.

The off balance sheet activity is where people seem to really be upset. I can understand his position. Acknowledging losses would have killed the firms reputation and sunk the firm. He was hired to solve these types of problems, and I don’t know if there was a better way to resolve them after they occurred. Saying this I’d still like to see him indited for fraud.

@BoBo1946 I can certainly sympathize with your anger at corporations. I don’t think you can just start an LLC, go public and dupe people into buying your shares however.
Your complaints seem to be more focused on politics and the consequences of a government without proper constitutional restraints. The actions you detest could easy be done by groups of individuals (dairy farmers), unions, or those who already have a state in the game.
Sounds like personal liability is your main cause for concern aside from the political manipulation. But isn’t everyone that loans money to these firms aware of their limited liability status and adjust rates accordingly. Its not like its a secret weapon.

@HungryGuy – I don’t think corporations are an invention of the government. They were invented by people for the good of people. The purpose of companies is to serve the needs of customers. The purpose of companies is not making employees or CEOs get super-rich while not serving the needs of customers.

@mattbrowne I’m not qualified to answer that. I don’t think anyone fully understands securities law. His situation seems similar to the s&l managers in the 80s. I’m not aware of any indictments for them.

I’m sure Andrew Cuomo would love to have an indictment. New York AGs have always seem more interested in their political future than faithfully applying the law.

Here’s another question: What is the difference between Goldman Sachs and the mafia?

Goldman sold tons of CDO and CDS products to customers promising excellent yield returns. Creating a bubble. At the same time they bought huge portion of Paulson’s hedge fund for the bank betting on a subprime crash. Which became a reality and Goldman made a huge profit for themselves and their customers lost all the money because the CDO and CDSs became worthless. This is fraud, isn’t it? Who will go to jail for that?

No Fraud. They didn’t “promise” excellent returns. They didn’t create the bubble. Goldman still lost money overall on the bets. That last point doesn’t really matter for fraud.
Look, they sold products people wanted. There is little evidence they misrepresented what the products contained. Customers were very invoked in choosing what was sold.
The difference between the mafia and Goldman: The mafia challenges the state’s attempt to monopolize the use of violence as a means of coercion. Goldman does not. Otherwise they are businesses, nothing more.